The nuclear option

At first blush, it seems like an odd form of suicide. On November 23, US-based technology giant Westinghouse Electric (owned by Toshiba, TOS.LSE, 6502.TYO) handed over some 75,000 documents containing its highly sensitive nuclear energy technology to China.

Transferring detailed information on the construction and maintenance of the AP1000, Westinghouse’s advanced third-generation nuclear power reactor, to a country known for its skill at out-competing rivals with cheap manufacturing might not appear to be the wisest of strategies. In a press conference announcing the transfer, Jack Allen, president of Westinghouse’s Asia division, acknowledged that there were “no guarantees” it would work.

China purchased four AP1000 reactors, or around 30% of the country’s anticipated nuclear power construction in the near term, from a consortium of Westinghouse and US-based Shaw Group (SHAW.NYSE) for US$8 billion in 2006. It is expected that with each reactor built the proportion of Chinese-sourced components will increase, to the point that by China’s fifth AP1000 reactor (of a total eight planned) Westinghouse will be phased out of the production process entirely.

The company’s moves are being watched closely by other foreign, mostly French, nuclear firms operating in China. “Right now the race [in China] is between [France’s] Areva (CEI.Euronext) and Westinghouse,” said Hans-Holger Rogner, head of planning and economic studies at the International Atomic Energy Agency (IAEA). Yet among many other analysts, he suspects that Westinghouse may have actually just gotten the better of its French rival.

French sophistication

French competition in China’s nuclear energy market comes primarily from two companies: Areva and Electricité de France (EDF; EDF.Euronext).

EDF is the largest French nuclear firm. It operates all 59 of France’s domestic nuclear plants and 95% of the country’s total electricity production, making it a quasi-monopoly. It often works in concert with reactor maker Areva, and France’s government has pushed for the two companies to pursue closer cooperation. France’s Alstom (ALO.Euronext) is also somewhat involved in China’s nuclear energy market, though it deals more prominently with hydropower.

What all French firms offer is the third-generation European Pressurized Reactor (EPR), a slightly more sophisticated competitor to Westinghouse’s AP1000. The EPR’s backers claim it is the safest, most efficient and advanced nuclear reactor in the world. Its double-containment safety features – it can survive a plane crash – are said to be unparalleled.

That does not necessarily mean it is successful. In December 2010 EDF and Areva were dealt a stinging blow when a US$40 billion Abu Dhabi contract was awarded to a South Korean consortium – including Westinghouse – to build AP1000 reactors.

Analysts point to two factors for the bid failure. The first is price: Consumers must pay a sharp premium for the EPR’s extra safety features.

“You could have triple containment, which makes it even safer. But the cost is a problem – at some point the investor will have to ask, do I really want to pay for that extra hypothetical safety insurance?” said the IAEA’s Rogner.

The second factor was the EPR’s dismal history of being behind schedule and over budget. Only two EPRs are currently under construction, one in France (begun 2006) and one in Finland (begun 2005). The Finnish reactor was supposed to come online in 2009, but it is now expected to be finished in 2013 – at a completion time of 86 months. Costs have spiraled from US$3.6 billion to around US$6.2 billion, causing German partner Siemens (SI.NYSE, SIE.FWB) to back out of the deal. The French reactor, meanwhile, has been delayed by two years, and costs have risen by 50% to US$6.6 billion.

This makes the China market all the more important for Areva and EDF. In 2007, the two companies signed a US$10.6 billion deal with China Guangdong Nuclear Power Corp (CGNPC) to build two EPRs in Taishan, Guangdong. The first reactor should come online in 2013 and the second in mid-2014. Crucially, both are on-time and on-budget.

If EDF and Areva can outperform on the Taishan project, they may not just be able to salvage the EPR’s reputation, but could have more deals lined up in China. The country currently has just 13 nuclear plants in operation. But 25 are under construction, and 120 more are confirmed in the pipeline.

Nuclear risks

This does not mean EDF and Areva can simply ignore dangers of selling advanced technology, of any sort, to China.

A Western-quality nuclear reactor can be built in China for about US$4 billion – 40% less than Areva’s offerings – and completed in about 46 months, compared with Areva’s estimated 71 months. Anne Lauvergeon, head of Areva, testified before the French Senate that Chinese manufacturers’ knowledge of the EPR nuclear technology was “very worrying,” and acknowledged that in some instances Chinese firms were more efficient than Areva.

For its part, China has made no secret of its ambitions. While so far China has exported commercial nuclear technology for only five reactors to Pakistan, CGNPC said it expects to start exporting reactors on a large scale by 2013. Others will no doubt follow suit.

Unexpectedly, Chinese firms have progressed even on the R&D side: China National Nuclear Corporation (CNNC) announced in early summer 2010 that it would start developing a new fourth-generation reactor in Fujian in 2012-2013; China Huaneng Group is also starting construction on a smaller-scale fourth-generation reactor.

But Chinese firms will find it hard to export their wares, at least initially. Safety is a crucial concern in the nuclear industry – one slip-up could spell disaster for suppliers and consumers globally. Unlike many other tech industries, customers will be less likely to gamble on new vendors. This fear is not only heightened by China’s reputation for less-than-stellar manufacturing quality, but also because the country’s nuclear safety authority has little clout.

As such, the government has been encouraging domestic firms to partner with foreign firms to compete in the global marketplace. CNNC’s partnership with Westinghouse to develop the first four AP1000 reactors could continue well into the future.

Americans make a move

This suits Westinghouse well. Daniel Money of Nicobar, a nuclear consultancy, points out that when the deal was being negotiated in 2005, Westinghouse faced a situation in which a glut of untested new supply had entered the market. “Except for Toshiba, none of [the third-generation models] have been built on time, on budget, or proven that they can be replicated. And there really isn’t room in the market for six of them.”

Westinghouse figured its best bet was to sacrifice the manufacturing and production side of the nuclear reactor business in favor of consulting and future brand recognition.

“If two or three other third-generations designs had been built before the AP1000, for all intents and purposes that means the AP1000 would have been dead forever and never been built,” noted Money.

Though it may lose control of the production side of the China market, the reputation boost would have had knock-on effects for other sales – such as the successful Abu Dhabi bid with the South Koreans.

Indeed, Westinghouse is pursuing the same strategy in China that it first developed to great effect in South Korea. “Our experience has been in the past that you can’t just give people drawings and manuals and they become proficient in a year or two years,” Westinghouse’s Allen said.

“Many of the exchanges we have worked on with other countries have gone on for 20 years, as with the Korea experience, so we continue
to share and enhance technology and understanding.”

The French alternative

Areva and EDF have taken a different strategy. “[In China’s nuclear energy market] it’s probably a choice between a greater market share or less technology transfer,” said Rajesh Panjwani, head of power research at CLSA Emerging Markets. “So it seems that one player has gone for a greater market share and has to do a greater technology transfer, and the other firm has gone the other way.”

When Areva and EDF entered China in the late 1980s and 1990s, the country had little market leverage, and few in the industry could have predicted the current global nuclear renaissance. French firms could negotiate highly favorable terms, include basing reactor production in France.

Tony Orvain, who works at the nuclear service section of the French embassy in Beijing, says that this distinction between manufacturing and consulting is what differentiates Areva and Westinghouse.

‘Areva has a lot of facilities to produce in France for the main components. Westinghouse can design it, but they can’t produce it. That’s a big difference,” Orvain said.

The French advantage will likely not last long. Areva and EDF are gradually joining Westinghouse in localizing production in China, while simultaneously moving into the branding, consulting and value-added services side.

“It’s the standard we see in many industries. They move from the hardware to the software. From manufacturing to R&D,” said IAEA’s Rogner.

But unlike Westinghouse, Areva and EDF are also involved in many other components of the nuclear production process, from sourcing commodities to back-end nuclear fuel reprocessing. For French firms, there’s more to the nuclear business than reactors.

Other opportunities

In fact, it may be in the non-reactor sectors that French firms can continue to thrive in the coming decades. “I would say the French strategy is to try to help [Chinese firms] develop their engineering,” said Arnaud Lefevre-Baril, director at Dynabond Powertech, a nuclear industry consultancy.

“As they get used to French nuclear codes, French firms can sell them nuclear power plants. Of course those firms can then extend that to the next stage, which is nuclear fuel reprocessing. And from our information the French should have a big share – maybe the whole cake – of reprocessing.”

It’s not an exaggeration. Orvain notes that very few companies in the world have the ability to compete in fuel reprocessing. “It’s the Russians and the French, and the Russian technology has some concerns about the environmental impact. So for the moment the French technology is the only one that can do it on a large scale,” said Orvain.

Such capabilities and components could become even more important than the reactors themselves, with the French continuing to be the preferred choice for cooperation.

“Irrespective of the fact that Westinghouse won the reactor deal, Areva’s mining subsidiary signed a uranium supply deal with CGNPC, locking in 25-30% of total output over the next 10 years,” said Nicobar’s Money. “They certainly have their fingers in a lot more things.”

Areva and EDF have been increasingly exploiting these niche markets. Aside from the US$3.5 billion uranium supply deal inked in November that Money alludes to, Areva is also in talks for a large joint venture reprocessing plant in China, and has established a joint venture with CNNC to produce zirconium tubes for fuel assembly fabrication, beginning in 2012.

These may only be the start. “New opportunities are up on the logistics, service and operations side,” said Money. “On the operations side there’s a whole universe of support related to running these plants as efficiently as possible. And then on the logistics side, just the coordination of that supply chain and the transportation of all these materials is going to grow 800% in 10 years.”

It is this staggering growth and scale that is ultimately propelling French nuclear firms forward in China.

CLSA’s Panjwani points out that 45% of reactors under construction globally are located in China. Of the 40 gigawatts of capacity that was under construction in 2009, 11 GW was in China. The country is the largest single market in terms of the total number of reactors currently under construction, as well as reactors confirmed in the pipeline.

Growing hunger

Under the Medium and Long-term Plan for Nuclear Power (2005-2020), published in 2007, China will have 40 GW capacity by 2020, supplying 4% of total energy consumption, with a further 18 GW under construction. But as China’s hunger for energy continues to exceed expectations, it has become increasingly clear that this figure will be insufficient to achieve the government’s broader development goals.

On November 1, China’s planning agency said that it was expanding nuclear power’s slice of the country’s total energy capacity pie in 2020 by 7%, raising it to 112 GW from 70 GW. Nuclear power will be an important part of the government’s efforts to expand the contribution of alternative energy in the country’s 12th Five-Year Plan, but the opportunities go well beyond the next five years.

By 2030 the country is projected to have 200 GW of installed capacity, and by 2050 the figure will double again to 400 GW. In total, most analysts expect China to spend about US$500 billion on as many as 245 reactors.

To be sure, other emerging markets also present opportunities for French nuclear firms. In December, Areva signed two agreements with Nuclear Power Corp of India for the construction of two EPRs in Maharashtra. As with its China deals, Areva will also supply the plants’ fuel for 25 years, and the site could eventually have six EPRs. The project is part of India’s ambitions to boost its nuclear energy capacity 14-fold from current levels by 2032.

This is impressive, but India is starting from a very low base – just 4.5 GW today – and so pales in comparison with China’s plans. By 2032 India will have 63 GW of nuclear generating capacity, a figure that China will hit before 2020. Put another way, China will add the equivalent of India’s current total nuclear capacity every year until 2030.

Hence, whether or not French firms’ strategy of branching out into non-reactor parts of the nuclear process pans out, they are likely to succeed simply by virtue of being part of China’s massively expanding nuclear industry. Orvain at the French embassy points out this growth eclipses anything on offer in France, or even in the US. However problematic China’s nuclear market and its technology transfers may be, French firms will have no choice but to continue their involvement.

The IAEA’s Rogner sums up their situation: “There was a bank robber in New York in the late 1940s. He was caught 40 or 50 times. And finally he was asked by a reporter, ‘Willy, why do you rob banks?’ And his answer was: ‘Because that’s where the money is’.

“It’s very simple. [China] is where the market is. It’s the only game in town.”

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